EQUITY RESEARCH July 26, 2017 The Best Growth Story in Tech? Our view: FB reported another strong quarter, with results coming in handily ahead of expectations and growth trends remaining intrinsically very impressive. FB also lowered its expense growth outlook. Raising estimates and increasing price target to $195. Reiterating Outperform still our No. 1 pick. Key points: Very Robust Q2 Results: Revenue grew 47% Y/Y ex-fx to $9.32B vs. RBC/Street estimates of $9.32/9.20B. After 16 quarters of 50%+ ex-fx Ad Revenue growth, FB majorly decelerated to 49%. Outperformance broad across geos, verticals, and ad-buying segments. EPS of $1.32 was far ahead of RBC/Street at $1.16/$1.12, helped by lower tax. FB lowered 17 opex growth from 40 50% to 40 45%. Headcount growth accelerating and video content spend will ramp in H2, but FB simply can t spend quickly enough to match its top-line growth. Good problem. Quarter Keys: 1. More Friends MAUs up 17% Y/Y (same as Q1) to 2.01B. 2. More Engagement DAU/MAU ratio (engagement measure) at 66.1%, up 16 bps Y/Y, with rising engagement in every region. 3. Rising Monetization ARPU up 24% Y/Y to $4.73, decel vs. 28% in Q1 albeit on tougher comp. 4. Strong FCF Generation and Share Repos $3.9B in Q2, with $150MM share repos. 5. Ad Impressions/Pricing Mix Impressions growth decelerated to 19% Y/Y (vs. 32% in Q1), but offset by 23% pricing growth (vs. 14% in Q1). Increasing Videos in newsfeed lowers impressions, but ROI is attractive enough (documented in our surveys) that advertisers willing to pay more. 6. Stepping Up Messaging Platform Monetization Though not material anytime soon, Zuckerberg said FB would step up monetization of Messenger and WhatsApp. Two B+ user platforms. Completely unmonetized. Hmm Modestly Raising Estimates and Price Target: 17 Rev unchanged at $39.9B, though GAAP Op Inc increased 1% to $18.4B and GAAP EPS raised 5% to $5.55, in part due to lowered tax rate. $195 PT (from $185) is based on 27x 18E GAAP EPS of $7.23 and 18x 18E EBITDA (incl. SBC) of $29.0B. Implies 22x Non-GAAP EPS and 16x Adjusted EBITDA for close to 40% 3-year CAGR. Good. Reiterating Outperform: 49% ex-fx Ad Revenue growth, 55% Adjusted EBITDA growth, and 47% FCF growth on a $36B revenue run-rate. FB might well be the Best Growth Story in Tech. Yes, we are incrementally more positive. Core FB is growing extremely well, with almost unprecedented Ad Revenue growth consistency. More important, we believe that FB s current low market shares approximately 15% of Global Online Advertising and 5% of Global Total Advertising will help it to maintain premium growth for a long time. And FB still has several new large revenue growth drivers (Instagram monetization, Messaging Platform monetization, Camera/AR AND Video). On valuation, we view 23x P/E on our 18E GAAP EPS as highly reasonable, especially for 40% + EPS growth. RBC Capital Markets, LLC Mark S.F. Mahaney (Analyst) (415) 633-8608 mark.mahaney@rbccm.com Dylan Haber (Senior Associate) (415) 633-8527 dylan.haber@rbccm.com Sector: Outperform NASDAQ: FB; USD 165.61 Jim Shaughnessy (AVP) (415) 633-8560 jim.shaughnessy@rbccm.com Price Target USD 195.00 185.00 WHAT'S INSIDE Rating/Risk Change Price Target Change In-Depth Report Est. Change Preview News Analysis Scenario Analysis* Downside Scenario 110.00 34% Current Price 165.61 *Implied Total Returns Key Statistics Shares O/S (MM): 2,951.0 Dividend: 0.00 Price Target 195.00 18% Upside Scenario 230.00 39% Market Cap (MM): 488,715 Yield: 0.0% Avg. Daily Volume: 17,483,470 RBC Estimates FY Dec 2016A 2017E 2018E 2019E Revenue 27.6 39.9 53.6 69.5 Prev. 53.5 69.3 GAAP Net EPS 3.50 5.55 7.23 9.43 Prev. 3.35 5.29 7.11 9.34 Margin 65.2% 63.9% 63.6% 63.5% P/E Net 47x 30x 23x 18x EBITDA 18.0 25.5 34.1 44.1 Prev. 18.1 25.0 33.9 44.3 Revenue Q1 Q2 Q3 Q4 2016 5.4A 6.4A 7.0A 8.8A 2017 8.0A 9.3A 10.0E 12.5E Prev. 8.8A EBITDA 2016 3.3A 4.2A 4.6A 6.0A 2017 4.9A 6.2A 6.2E 8.3E Prev. 5.7E All values in USD unless otherwise noted. Disseminated: Jul 26, 2017 22:08ET; Produced: Jul 26, 2017 22:08ET Priced as of prior trading day's market close, EST (unless otherwise noted). For Required Conflicts Disclosures, see Page 11.
Target/Upside/Downside Scenarios Exhibit 1: 125 Weeks 05MAR15-26JUL17 200 UPSIDE 230.00 180 TARGET 195.00 CURRENT 160 165.61 140 130 120 110 100 90 80 70 600m 400m 200m 2015 M A M J J A S O N 2016 D J F M A M J J A S O N 2017 D J F M A M J FB Rel. S&P 500 COMPOSITE MA 40 weeks Source: Bloomberg and RBC Capital Markets estimates for Upside/Downside/Target J DOWNSIDE 110.00 Jul 2018 Target price/base case We value Facebook using a blended average of 27x P/E multiple and 18x EV/EBITDA multiple on our 2018 estimates. In our EBITDA calculation, we are treating Stock-Based Compensation as an expense and not adjusting it out. For key context, we are estimating 39% EPS and 37% EBITDA CAGRs for FB through 2019, which we believe supports these premium multiples. Our $195 price target is also supported by a DCF, assuming a 12% WACC and a 3% Terminal Growth Rate. Our price target supports our Outperform rating. Upside scenario In our upside scenario of $230, we estimate a 50% 2-year Revenue CAGR as user growth and sustained engagement drives Ad Revenue. Higher Revenue growth drives EBITDA margins to 72% by 2017. We apply a 40x P/E multiple and a 28x EV/EBITDA multiple. Investment summary Our Outperform rating is based on several key factors: 1) Very Large, Growing User Base Facebook has more than 2B active users and is still growing this in the teens % Y/Y. The large amount of data collected on these users is a unique and valuable asset for ad and content targeting. 2) Engagement Still High Although engagement levels are a constant concern, Facebook's measure of DAU/MAU has remained consistently high on an overall company basis. 3) One of the Most "Underlevered" Companies Facebook still has many growth levers left to pull, not least of which is video advertising. 4) Mobile Overhang Addressed Facebook has, so far, effectively addressed one of the most significant overhangs from its IPO days, the lack of Mobile monetization. Mobile Ad Revenue is now showing significant growth and becoming a material part of the overall Ad Revenue mix (88%). 5) Very High Margins FB currently drives EBITDA margins in the low-60%s. An outlook for increased opex investment should drive these down, but we think that increased investment is actually a positive at this point in the company's growth. Risks to Our Price Target Include: 1) Broad decreasing engagement trends as new competitors arise and take market share; 2) failure to drive significant adoption from major advertising brands; 3) limitations due to regulatory/user actions on privacy concerns; and 4) poor user reaction to site redesign/new product initiatives. Downside scenario In our downside scenario of $110, we assume that user growth slows more quickly than expected and that engagement begins to slip in mature geographies. This causes both a deceleration in ad volume growth and pricing pressure as more incremental ads come from lower-monetizing geographies. We apply a 25x P/E multiple and 15x EV/EBITDA multiple. July 26, 2017 Mark S.F. Mahaney, (415) 633-8608; mark.mahaney@rbccm.com 2
Facebook Q2:17 EPS Roundup Metric Trends 2 BILLIIIIOOON MAUs Monthly Active Users Monthly Active Users (MAU) grew 17% Y/Y, in line with 17% in Q1 on a flat comp. This is the fastest growth since Q3:13, with the total reaching 2.01B, above Street estimates at 1.98B. This overall growth rate remains very impressive given FB s massive size and don t forget that FB MAU s don t include Instagram (700MM+ MAUs) or WhatsApp (over 1.2B MAUs). North America Y/Y MAU growth slightly decreased to 4% Y/Y in Q2 (vs. 5 6% in prior seven quarters); Europe growth accelerated slightly to 7% Y/Y (from 6% in Q1) while ROW growth decreased slightly to 18% Y/Y growth (vs. 19% growth in Q1). The growth driver here? Asia, which accelerated and grew 28% Y/Y from 27% Y/Y growth in Q1. Facebook and its properties now officially have more than 2B unique users worldwide on a monthly basis (i.e., FB > China), including well, well over 1B users worldwide on a daily basis (1.3B as of Q2). Google is the only other global media company with properties with more than 1B daily users. And look at how big their market cap is...a few factors helping FB at the margin are product improvements, continued traction of Facebook Lite version for Android phones, the growth of.org, and the increase in third-party promotional free data plans in Asia and the rest of the world. Facebook now has more than 2B MAUs and that doesn t even include Instagram and WhatsApp. The company s growth continues to remain robust and defies the Large Numbers Law, with growth accelerating in Asia and Europe. Exhibit 2: Monthly Active Users and Growth 2,250 30% 2,000 1,750 1,500 1,250 1,000 15% 1,276 1,591 1,546 1,491 1,441 1,394 1,317 1,351 14% 14% 14% 13% 13% 14% 14% 1,654 1,712 1,787 15% 15% 16% 2,006 1,859 1,936 17% 17% 17% 25% 20% 15% 10% 750 5% 500 Q1:14 Q2:14 Q3:14 Q4:14 Q1:15 Q2:15 Q3:15 Q4:15 Q1:16 Q2:16 Q3:16 Q4:16 Q1:17 Q2:17 Monthly Active Users (left) Y/Y Growth (Right) 0% Source: Company reports, RBC Capital Markets Engagement Trends Overall engagement levels in Q2:17 were consistnet in terms of the DAU/MAU Metric (Daily Average Users/Monthly Average Users, Facebook s best publicly disclosed proxy for engagement). The DAU/MAU ratio was 66.1% in Q2, down slightly from from 66.3% in Q1 and up 16 bps Y/Y. This was below our 66.6% expectation, though the Q/Q decline is seasonally consistent with prior years. The metric was up Y/Y in all regions notably up 147 bps in Asia and 72 bps in Europe. These remain robust trends, especially in Facebook s most mature geographies, and we believe Mobile is a major driving factor, along with ongoing July 26, 2017 Mark S.F. Mahaney, (415) 633-8608; mark.mahaney@rbccm.com 3
product and feature improvements. Engagement remains robust, with our thesis remaining that Facebook can continue to steadily increase engagement over time and, in turn, attract more Ad dollars. Exhibit 3: Engagement (Daily Active Users/Monthly Active Users) Geographic Breakdown 85% 80% 75% 70% 65% 60% 55% 50% 74.3% 74.5% 75.2% 75.5% 76.7% 77.0% 77.0% 77.2% 77.9% 77.4% 77.7% 77.9% 77.8% 77.5% 70.2% 70.5% 71.6% 72.1% 73.3% 73.3% 74.0% 74.3% 74.8% 74.6% 74.9% 75.1% 75.4% 75.3% 61.8% 62.0% 62.6% 62.7% 63.8% 63.8% 64.2% 64.0% 64.6% 64.1% 60.5% 59.0% 59.4% 60.3% 55.4% 55.6% 56.8% 56.3% 57.3% 57.5% 57.5% 57.2% 58.1% 58.4% 58.5% 58.8% 59.6% 59.9% 45% 40% Q1:14 Q2:14 Q3:14 Q4:14 Q1:15 Q2:15 Q3:15 Q4:15 Q1:16 Q2:16 Q3:16 Q4:16 Q1:17 Q2:17 US & Canada Europe Asia Rest of World Source: Company reports, RBC Capital Markets Global ARPU Global ARPU grew 24% Y/Y to $4.73 in Q2, decelerating 4-pts against Q1 s 28% Y/Y growth, albeit on a 6-pt tougher comp. The increase in ARPU is being driven by Ad Revenue, which grew 25% Y/Y on a per-user basis, compared to a 32% decline in Payments ARPU per-user. Rising ARPU is a positive sign for advertiser traction and the company s ability to monetize incremental users/usage. Going forward, given management s commentary around focus on new ad units and ad load, ARPU will be a key metric to determine Ad Revenue growth. With Google s ARPU still materially above Facebook, we believe there is plenty more monetization runway for FB. Exhibit 4: Global ARPU and Growth $5.5 60% $5.0 $4.5 $4.0 $3.5 $3.0 $2.5 $2.0 $1.5 49% $2.00 40% 40% $2.24 $2.40 31% $2.81 25% $2.50 $2.96 $2.76 23% 23% $3.82 $3.72 $3.32 39% 33% 33% $4.01 35% $4.83 $4.23 30% 28% $4.73 24% 50% 40% 30% 20% 10% $1.0 Q1:14 Q2:14 Q3:14 Q4:14 Q1:15 Q2:15 Q3:15 Q4:15 Q1:16 Q2:16 Q3:16 Q4:16 Q1:17 Q2:17 Global ARPU (left) Y/Y Growth (right) 0% Source: Company reports, RBC Capital Markets July 26, 2017 Mark S.F. Mahaney, (415) 633-8608; mark.mahaney@rbccm.com 4
Exhibit 5: Revenue Growth Trends Source: Company reports Ad Metrics Facebook stated that Ad Impressions in the quarter grew 19% Y/Y (Driven by Mobile Ad impressions), down from the 32% Y/Y delivered in Q1 and the 49% Y/Y growth seen in Q4. However, we continue to believe this data point is largely noise, especially with continual ad format changes; the company noted that the emphasis on long-form Video in the News Feed negatively impacted Ad Impressions as well. Further, we note management stated that pricing increased 24% (vs. 14% in Q1, 3% in Q4, 6% in Q3 and 9% in Q216). Per our published survey work, the ROIs on FB ad campaigns continue to be viewed very positively by marketers, so we expect pricing/yield to keep rising. We continue to look at the growth in overall advertising revenue as the most important factor for FB, which at 49% Y/Y growth (ex-fx) in Q2 is a positive outcome for a business that did $28B in Revenue in 2016 especially one with 60%+ EBITDA Margins. In fact, Google is the only other platform that comes to mind as being able to do this in 2007. We continue to believe Facebook s focus on ads quality is the right strategy, particularly given management s consistent commentary around ad loads being a less significant factor for growth starting in H2:17. We also think Video Ads (especially with general user adoption of Videos), Carousel Ads, Canvas Ads, Dynamic Ads, and Instagram monetization will be key parts of this trend over the next two years. Revenue Results Above Expectations Total Revenue grew 45% Y/Y to $9.32B in Q2:17, above RBC/Street estimates of $9.30/9.20B. The key number here was the Advertising Revenue segment (98% of total revenue), which grew 49% Y/Y ex-fx, vs. 51% Y/Y growth in Q1 on a flat comp. Mobile continued to drive positive results, growing 52% Y/Y (vs. 57% in Q1) on a reported basis to ~$8B in revenue, above the Street s estimate of $7.65B. Looking ahead, management maintained that it expects Ad Load to play a less significant factor for driving revenue growth in 2H17. The commentary on the Q2 EPS call was similar to that on the Q1 EPS call and the Q4 EPS call and the Q3 EPS call. ($ MM) Q1:15 Q2:15 Q3:15 Q4:15 Q1:16 Q2:16 Q3:16 Q4:16 Q1:17 Q2:17 Total Revenue 3,543 4,042 4,501 5,841 5,382 6,436 7,011 8,809 8,032 9,321 Y/Y Change 42% 39% 41% 52% 52% 59% 56% 51% 49% 45% Q/Q Change -8% 14% 11% 30% -8% 20% 9% 26% -9% 16% Advertising Revenue 3,317 3,827 4,299 5,637 5,201 6,239 6,816 8,629 7,857 9,164 Y/Y Change 46% 43% 45% 57% 57% 63% 59% 53% 51% 47% Y/Y Change (ex-fx) 55% 55% 57% 66% 63% 63% 59% 54% 51% 49% Q/Q Change -8% 15% 12% 31% -8% 20% 9% 27% -9% 17% % of Total 94% 95% 96% 97% 97% 97% 97% 98% 98% 98% Desktop Ad Revenue 896 918 946 1,127 936 998 1,091 1,381 1,179 1,191 Y/Y Change -4% -10% -6% 1% 5% 9% 15% 22% 26% 19% % of Total Ad Revenue 27% 24% 22% 20% 18% 16% 16% 16% 15% 13% Mobile Ad Revenue 2,421 2,909 3,353 4,510 4,265 5,241 5,725 7,248 6,678 7,973 Y/Y Change 81% 75% 72% 82% 76% 80% 71% 61% 57% 52% % of Total Ad Revenue 73% 76% 78% 80% 82% 84% 84% 84% 85% 87% Payments & Other Revenue 226 215 202 204 181 197 195 180 175 157 Y/Y Change -5% -8% -18% -21% -20% -8% -3% -12% -3% -20% Q/Q Change -12% -5% -6% 1% -11% 9% -1% -8% -3% -10% July 26, 2017 Mark S.F. Mahaney, (415) 633-8608; mark.mahaney@rbccm.com 5
Exhibit 6: Non-GAAP Operating Margins and EBITDA Margins Source: Company reports, RBC Capital Markets Margin Trends Expense Growth Materially Lower than Expected In Q2:17, total GAAP Opex grew 33% Y/Y (vs. 40% in Q1). In Q2, Facebook delivered Adj. EBITDA margins of 66%, ahead of our estimate of 61.2% and marking a 180 bps Y/Y increase. Facebook is currently in an investment cycle for both Capital Expenses and Operating Expenses, which generally places pressure on margins. As we have noted in other cases, we believe this is the right step for management to take and are comfortable trading nearterm margins for long-term growth. Q1:15 Q2:15 Q3:15 Q4:15 Q1:16 Q2:16 Q3:16 Q4:16 Q1:17 Q2:17 GAAP Operating Income 933 1,273 1,459 2,560 2,010 2,734 3,117 4,566 3,327 4,401 Margin 26% 31% 32% 44% 37% 42% 44% 52% 41% 47% Adjusted EBITDA 2,118 2,507 2,716 3,875 3,308 4,136 4,532 6,028 4,865 6,161 Margin 60% 62% 60% 66% 61% 64% 65% 68% 61% 66% Additional Datapoints 2017 Guidance In terms of 2017 outlook, the company tightened its GAAP expense growth range to 40 45% from the prior 40 50% Y/Y range; Video content investments will contribute to OpEx growth in 2H17. The company expects its headcount growth rate to accelerate in the second half of the year as it remains deep correctly, in our view in investment mode. Facebook now sees Capital Expenditures to be on the lower end of the previously guided range of $7 7.5B (up 50% Y/Y) as it expands data center capacity and office facilities. Under its new accounting guidance, FB s tax will fluctuate with stock price at current stock prices, the company expects that its Q3 and FY17 tax rates will both be similar to Q2 (13%). The company didn t break out SBC or Amortization expectations, but we note that on the Q4 call it expected full-year 2017 Share-Based Compensation expense in the range of $3.9 4.1B, with $1.3B of that allocated to the WhatsApp acquisition (WhatsApp related SBC ends in late 18) and 2017 amortization expenses of $700 800MM. Lastly, management continues to expect Ad Revenue growth to decline as the year progresses and expects Desktop Ad Revenue growth rates to slow in 2H17 as the company begins to lap efforts to limit the impact of ad blockers. The company also expects Payments and Other Fees revenue to decline compared to 2016. Strong Cash Position Facebook reported Cash and Marketable Securities of $35B at the end of Q2. Free Cash Flow was a very hefty $3.9B. Capital expenditures were $1.44B in Q2 the company expects the lower end of $7 7.5B of CapEx in 2017. All in, we continue to view Facebook s liquidity position as unusually strong and continuing to improve. Miscellaneous Notes from Earnings Stories Feature on Apps: Instagram Stories now has more than 250MM Daily Active Users using it, while WhatsApp Stories also has more than 250MM Daily Active users. This quarter, the company added the ability to reply to Stories with a photo or video and share replay of a live video on Instagram. Lastly, the company also rolled out Ads for more types of marketer objectives in Q2. July 26, 2017 Mark S.F. Mahaney, (415) 633-8608; mark.mahaney@rbccm.com 6
Stock Repurchase Program: Facebook s Board of Directors authorized a $6B stock repurchase program in Q4 that began in early 2017 with no expiration date. The company noted at the time that it was in a financial position to make opportunistic repurchases of common stock from time to time to offset dilution from equity issuance. In Q2, FB repurchased $150MM of Class A common stock (vs. $228MM in Q1). Businesses: Facebook now has more than 70MM Monthly Active Business pages on its platform. There are now also more than 5MM Businesses advertising on Facebook, including 1MM in emerging markets. Notably, the company highlighted today that it has more than 15MM business profiles on Instagram. AI: The company noted that it is finding AI (artificial intelligence) to deliver consistent improvements to many of its systems, such as newsfeed, search, ads, security, and filtering. The company expects the business to change the way that it does business; for example, by having AI flag content that might violate community standards in advance of people having to flag it. AI is also finding the best people to target with marketing, doing a better job than someone could manually. Facebook Communities: The company noted that its new mission is to bring the world closer together and to do this through building meaningful communities. FB again noted that it has 100MM people on Facebook who are in very meaningful groups, such as parenting or rare disease support. The company wants to help more than 1B join meaningful communities, and in the six months that it has started working on this (with AI and suggested groups), it has already helped more than 50% more people join meaningful communities than before. Messenger Monetization: It is still early with monetization, though the company has noted that it has started showing ads to a small number of people on messenger. Watch this space with a five-year eyeglass. Data Centers: In Q2, the company launched its Ft. Worth data center, which uses 100% renewable energy. The company is also breaking ground on its New Mexico and Iowa data centers. Advertiser Tools: One of the company s key priorities is making ads more relevant and effective to better target and measure ads across Facebook, Instagram, and Audience Networks. Marketers with FB are optimizing their ads to drive real-world outcomes rather than focusing on page likes or video use; 53% of its Revenue from SMBs now come from campaigns that use these strategies and tools, vs. 23% at the beginning of 2016.The company also introduced Value Optimization in Q2 to show ads to people who are most likely to spend and it introduced value-based Lookalike Audiences that use machine learning to help marketers reach people who are similar to their current customers. Changes to Estimates Below we present the changes to our 2017 and 2018 estimates. Exhibit 7: Estimate Revisions 2017E 2018E ($ MM) Old New % Change Old New % Change Revenue 39,851 39,920 0.2% 53,506 53,608 0.2% Adjusted EBITDA 25,022 25,534 2.0% 33,873 34,124 0.7% GAAP Op Inc. 18,180 18,371 1.1% 25,412 25,527 0.5% GAAP EPS $5.29 $5.55 4.8% $7.11 $7.23 1.6% Source: RBC Capital Markets estimates July 26, 2017 Mark S.F. Mahaney, (415) 633-8608; mark.mahaney@rbccm.com 7
Valuation Methodology We raise our price target to $195 (from $185). Our 2018 valuation framework is based on an average of GAAP P/E and EV/EBITDA methodologies. In our EBITDA calculation, we are treating Stock-Based Compensation as an expense and not adjusting it out. Our P/E valuation framework applies a 27x target multiple to our 2018 GAAP EPS estimate of $7.23 to arrive at our $195 price target. For key context, Facebook is trading at 30x 2017E EPS and 23x 2018E EPS. Furthermore, our estimates imply a 3-year 39% EPS CAGR, which we believe reasonably supports a target multiple of 27x. Our EV/EBITDA valuation framework applies an 18.0x target multiple to our 2018 EBITDA estimate of $29B to arrive at a $192/share valuation. For key context, Facebook is trading at 21x 2017E EBITDA and 16x 2018E EBITDA. Furthermore, our estimates imply a 3-year 37% EBITDA CAGR. We combine these two valuation frameworks and round the result, yielding our $195 price target. Exhibit 8: Valuation Methodologies ($ in millions, except per share amounts) Current Price (After Market) $171.25 Diluted Shares Outstanding 2,951 Current Market Cap 505,359 Less: Cash and Cash Equivalents 35,452 Plus: Debt 0 Enterprise Value 469,907 Price to GAAP EPS 2018E GAAP EPS $7.23 Current P/E on '17 GAAP EPS 30.9x Current P/E on '18 GAAP EPS 23.7x EPS CAGR '16-'19 39% Target Multiple 27.0x Implied Stock Price on Forward EPS $195 EV to EBITDA (incl. SBC) 2018E EBITDA (incl. SBC) 29,032 Current EV/EBITDA on '17 EBITDA 22.0x Current EV/EBITDA on '18 EBITDA 16.2x EBITDA CAGR '16-'19 37% Target Multiple 18.0x Enterprise Value 522,570 Plus: '17 YE Cash 44,597 Less: '17 YE Debt 0 Equity Market Capitalization 567,166 Implied Stock Price on Forward EBITDA $192 Target Price $195 Source: RBC Capital Markets estimates, Company reports, FactSet. Priced in the after-market as of 7:30PM EST on July 26, 2017 July 26, 2017 Mark S.F. Mahaney, (415) 633-8608; mark.mahaney@rbccm.com 8
Valuation We value Facebook using a blended average of 27x P/E multiple and 18x EV/EBITDA multiple on our 2018 estimates. In our EBITDA calculation, we are treating Stock-Based Compensation as an expense and not adjusting it out. For key context, we are estimating 39% EPS and 37% EBITDA CAGRs for FB through 2019, which we believe supports these premium multiples. Our $195 price target is also supported by a DCF, assuming a 12% WACC and a 3% Terminal Growth Rate. Our price target supports our Outperform rating. Risks to rating and price target Risks to our price target and rating include but are not limited to: 1) broad decreasing engagement trends as new competitors arise and take market share; 2) failure to drive significant adoption from major advertising brands; 3) limitations due to regulatory/user actions on privacy concerns; and 4) poor user reaction to site redesign/new product initiatives. Company description Founded in 2004 and headquartered in Menlo Park, California, Facebook is the world s most popular social networking site with more than 2B users. Through its flagship website, facebook.com, as well as mobile apps and various other tools, Facebook enables users to connect, share, discover, and communicate with each other. Facebook also provides a platform on which developers can build social apps and integrate their own websites with Facebook, further enhancing interactivity among users. Facebook generates revenue primarily through two channels: Advertising (98%) and Payments/Other (2%). July 26, 2017 Mark S.F. Mahaney, (415) 633-8608; mark.mahaney@rbccm.com 9
($ Millions, Except EPS) 2015A 2016A 2017E 3/15A 6/15A 9/15A 12/15A 3/16A 6/16A 9/16A 12/16A 3/17A 6/17A 9/17E 12/17E 2015A 2016A 2017E 2018E 2019E Total Revenue $3,543 $4,042 $4,501 $5,841 $5,382 $6,436 $7,011 $8,809 $8,032 $9,321 $10,046 $12,521 $17,927 $27,638 $39,920 $53,608 $69,464 Cost Of Revenue 636 646 699 802 816 888 957 1,015 1,125 1,190 1,271 1,317 2,783 3,676 4,903 6,424 8,115 Gross Profit 2,907 3,396 3,802 5,039 4,566 5,548 6,054 7,794 6,907 8,131 8,775 11,203 15,144 23,962 35,017 47,184 61,348 Operating Expenses 1,974 2,123 2,343 2,479 2,556 2,814 2,937 3,228 3,580 3,730 4,442 4,893 8,919 11,535 16,646 21,658 27,508 Marketing & Sales 544 542 622 686 744 806 831 1,020 961 1,004 1,206 1,477 2,394 3,401 4,648 6,165 7,919 Research & Development 479 560 663 709 757 840 906 910 1,164 1,132 1,437 1,502 2,411 3,413 5,235 6,969 8,961 G&A 223 246 287 312 309 351 376 450 588 562 703 751 1,068 1,486 2,604 3,431 4,376 Stock Based Compensation 728 775 771 772 746 817 824 848 867 1,032 1,097 1,162 3,046 3,235 4,158 5,093 6,252 Other 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 GAAP Operating Income 933 1,273 1,459 2,560 2,010 2,734 3,117 4,566 3,327 4,401 4,333 6,310 6,225 12,427 18,371 25,527 33,841 Non-GAAP Operating Income 1,840 2,228 2,410 3,523 2,936 3,744 4,136 5,597 4,384 5,623 5,620 7,662 10,001 16,413 23,289 31,379 40,852 Depreciation 278 279 306 352 372 392 396 431 481 538 588 638 1,215 1,591 2,245 2,745 3,245 Adjusted EBITDA 2,118 2,507 2,716 3,875 3,308 4,136 4,532 6,028 4,865 6,161 6,208 8,300 11,216 18,004 25,534 34,124 44,097 Other Income/(Expense) -1 0-27 -3 56 20 47-33 81 87 107 127-31 90 402 600 800 GAAP Pre-Tax Income 932 1,273 1,432 2,557 2,066 2,754 3,164 4,533 3,408 4,488 4,440 6,437 6,194 12,517 18,773 26,127 34,641 GAAP Taxes 420 554 536 995 328 471 537 965 344 594 588 852 2,505 2,301 2,378 4,442 5,889 Net Income 512 719 896 1,562 1,738 2,283 2,627 3,568 3,064 3,894 3,852 5,585 3,689 10,216 16,395 21,685 28,752 Non-GAAP Pre-Tax Income 1,839 2,228 2,383 3,520 2,992 3,764 4,183 5,564 4,465 5,710 5,727 7,789 9,970 16,503 23,691 31,979 41,652 Non-GAAP Taxes 650 791 755 1255 804 963 1035 1414 990 894 897 1220 3,451 4,216 4,002 5,437 7,081 Non-GAAP Net Income $1,189 $1,437 $1,628 $2,265 $2,188 $2,801 $3,148 $4,150 $3,475 $4,816 $4,830 $6,569 $6,519 $12,287 $19,689 $26,543 $34,572 GAAP EPS $0.18 $0.25 $0.31 $0.54 $0.60 $0.78 $0.90 $1.21 $1.04 $1.32 $1.30 $1.88 $1.29 $3.50 $5.55 $7.23 $9.43 Non-GAAP EPS $0.42 $0.50 $0.57 $0.79 $0.76 $0.96 $1.08 $1.41 $1.18 $1.63 $1.63 $2.21 $2.28 $4.21 $6.66 $8.85 $11.33 Diluted Shares 2,836 2,850 2,863 2,878 2,888 2,921 2,915 2,938 2,944 2,951 2,961 2,971 2,857 2,916 2,957 3,000 3,050 Growth Rate Revenue (Y/Y) 42% 39% 41% 52% 52% 59% 56% 51% 49% 45% 43% 42% 44% 54% 44% 34% 30% Revenue, ex-fx (Y/Y) 49% 50% 50% 60% 58% 59% 56% 51% 50% 47% 43% 42% 53% 56% 45% 34% 30% Revenue (Q/Q) -8% 14% 11% 30% -8% 20% 9% 26% -9% 16% 8% 25% -- -- -- -- -- Non-GAAP Operating Income (Y/Y) 30% 27% 32% 59% 60% 68% 72% 59% 49% 50% 36% 37% 39% 64% 42% 35% 30% Adjusted EBITDA (Y/Y) 29% 27% 32% 57% 56% 65% 67% 56% 47% 49% 37% 38% 38% 61% 42% 34% 29% GAAP EPS (Y/Y) -27% -17% 3% 118% 233% 210% 188% 124% 73% 69% 44% 55% 17% 171% 58% 30% 30% Non-GAAP EPS (Y/Y) 18% 18% 31% 46% 81% 90% 90% 79% 56% 70% 51% 57% 29% 85% 58% 33% 28% Margin Analysis Gross Margin 82.0% 84.0% 84.5% 86.3% 84.8% 86.2% 86.4% 88.5% 86.0% 87.2% 87.4% 89.5% 84.5% 86.7% 87.7% 88.0% 88.3% GAAP Operating Margin 26.3% 31.5% 32.4% 43.8% 37.3% 42.5% 44.5% 51.8% 41.4% 47.2% 43.1% 50.4% 34.7% 45.0% 46.0% 47.6% 48.7% Non-GAAP Operating Margin 51.9% 55.1% 53.5% 60.3% 54.6% 58.2% 59.0% 63.5% 54.6% 60.3% 55.9% 61.2% 55.8% 59.4% 58.3% 58.5% 58.8% Adjusted EBITDA Margin 59.8% 62.0% 60.3% 66.3% 61.5% 64.3% 64.6% 68.4% 60.6% 66.1% 61.8% 66.3% 62.6% 65.1% 64.0% 63.7% 63.5% Expenses as Pct. of Revenue Marketing & Sales 15.4% 13.4% 13.8% 11.7% 13.8% 12.5% 11.9% 11.6% 12.0% 10.8% 12.0% 11.8% 13.4% 12.3% 11.6% 11.5% 11.4% Research & Development 13.5% 13.9% 14.7% 12.1% 14.1% 13.1% 12.9% 10.3% 14.5% 12.1% 14.3% 12.0% 13.4% 12.3% 13.1% 13.0% 12.9% G&A 6.3% 6.1% 6.4% 5.3% 5.7% 5.5% 5.4% 5.1% 7.3% 6.0% 7.0% 6.0% 6.0% 5.4% 6.5% 6.4% 6.3% Share-Based Compensation 20.5% 19.2% 17.1% 13.2% 13.9% 12.7% 11.8% 9.6% 10.8% 11.1% 10.9% 9.3% 17.0% 11.7% 10.4% 9.5% 9.0% GAAP Tax Rate 45.1% 43.5% 37.4% 38.9% 15.9% 17.1% 17.0% 21.3% 10.1% 13.2% 13.2% 13.2% 40.4% 18.4% 12.7% 17.0% 17.0% Non-GAAP Tax Rate 35.3% 35.5% 31.7% 35.7% 26.9% 25.6% 24.7% 25.4% 22.2% 15.7% 15.7% 15.7% 34.6% 25.5% 16.9% 17.0% 17.0% Source: Company Reports, RBC Capital Markets estimates July 26, 2017 Mark S.F. Mahaney, (415) 633-8608; mark.mahaney@rbccm.com 10
Required disclosures Conflicts disclosures The analyst(s) responsible for preparing this research report received compensation that is based upon various factors, including total revenues of the member companies of RBC Capital Markets and its affiliates, a portion of which are or have been generated by investment banking activities of the member companies of RBC Capital Markets and its affiliates. Please note that current conflicts disclosures may differ from those as of the publication date on, and as set forth in, this report. To access current conflicts disclosures, clients should refer to https://www.rbccm.com/gldisclosure/publicweb/ DisclosureLookup.aspx?entityId=1 or send a request to RBC CM Research Publishing, P.O. Box 50, 200 Bay Street, Royal Bank Plaza, 29th Floor, South Tower, Toronto, Ontario M5J 2W7. RBC Capital Markets, LLC makes a market in the securities of. RBC Capital Markets has provided with non-securities services in the past 12 months. Facebook's common shares consist of both a Class A and Class B issue. The holder of each share of Class A common stock is entitled to one vote, while the holder of each share of Class B common stock is entitled to ten votes. Any transfer of shares of Class B common stock will generally result in those shares converting to Class A common stock. Explanation of RBC Capital Markets Equity rating system An analyst's 'sector' is the universe of companies for which the analyst provides research coverage. Accordingly, the rating assigned to a particular stock represents solely the analyst's view of how that stock will perform over the next 12 months relative to the analyst's sector average. Although RBC Capital Markets' ratings of Top Pick (TP)/Outperform (O), Sector Perform (SP), and Underperform (U) most closely correspond to Buy, Hold/Neutral and Sell, respectively, the meanings are not the same because our ratings are determined on a relative basis. Ratings Top Pick (TP): Represents analyst's best idea in the sector; expected to provide significant absolute total return over 12 months with a favorable risk-reward ratio. Outperform (O): Expected to materially outperform sector average over 12 months. Sector Perform (SP): Returns expected to be in line with sector average over 12 months. Underperform (U): Returns expected to be materially below sector average over 12 months. Risk Rating As of March 31, 2013, RBC Capital Markets suspends its Average and Above Average risk ratings. The Speculative risk rating reflects a security's lower level of financial or operating predictability, illiquid share trading volumes, high balance sheet leverage, or limited operating history that result in a higher expectation of financial and/or stock price volatility. Distribution of ratings For the purpose of ratings distributions, regulatory rules require member firms to assign ratings to one of three rating categories - Buy, Hold/Neutral, or Sell - regardless of a firm's own rating categories. Although RBC Capital Markets' ratings of Top Pick(TP)/ Outperform (O), Sector Perform (SP), and Underperform (U) most closely correspond to Buy, Hold/Neutral and Sell, respectively, the meanings are not the same because our ratings are determined on a relative basis (as described above). Distribution of ratings RBC Capital Markets, Equity Research As of 30-Jun-2017 Investment Banking Serv./Past 12 Mos. Rating Count Percent Count Percent BUY [Top Pick & Outperform] 826 52.01 293 35.47 HOLD [Sector Perform] 657 41.37 144 21.92 SELL [Underperform] 105 6.61 7 6.67 July 26, 2017 Mark S.F. Mahaney, (415) 633-8608; mark.mahaney@rbccm.com 11
References to a Recommended List in the recommendation history chart may include one or more recommended lists or model portfolios maintained by RBC Wealth Management or one of its affiliates. RBC Wealth Management recommended lists include the Guided Portfolio: Prime Income (RL 6), the Guided Portfolio: Dividend Growth (RL 8), the Guided Portfolio: ADR (RL 10), and the Guided Portfolio: All Cap Growth (RL 12), and former lists called the Guided Portfolio: Large Cap (RL 7), the Guided Portfolio: Midcap 111 (RL 9), and the Guided Portfolio: Global Equity (U.S.) (RL 11). RBC Capital Markets recommended lists include the Strategy Focus List and the Fundamental Equity Weightings (FEW) portfolios. The abbreviation 'RL On' means the date a security was placed on a Recommended List. The abbreviation 'RL Off' means the date a security was removed from a Recommended List. Equity valuation and risks For valuation methods used to determine, and risks that may impede achievement of, price targets for covered companies, please see the most recent company-specific research report at https://www.rbcinsight.com or send a request to RBC Capital Markets Research Publishing, P.O. Box 50, 200 Bay Street, Royal Bank Plaza, 29th Floor, South Tower, Toronto, Ontario M5J 2W7. Valuation We value Facebook using a blended average of 27x P/E multiple and 18x EV/EBITDA multiple on our 2018 estimates. In our EBITDA calculation, we are treating Stock-Based Compensation as an expense and not adjusting it out. For key context, we are estimating 39% EPS and 37% EBITDA CAGRs for FB through 2019, which we believe supports these premium multiples. Our $195 price target is also supported by a DCF, assuming a 12% WACC and a 3% Terminal Growth Rate. Our price target supports our Outperform rating. Risks to rating and price target Risks to our price target and rating include but are not limited to: 1) broad decreasing engagement trends as new competitors arise and take market share; 2) failure to drive significant adoption from major advertising brands; 3) limitations due to regulatory/user actions on privacy concerns; and 4) poor user reaction to site redesign/new product initiatives. Conflicts policy RBC Capital Markets Policy for Managing Conflicts of Interest in Relation to Investment Research is available from us on request. To access our current policy, clients should refer to https://www.rbccm.com/global/file-414164.pdf or send a request to RBC Capital Markets Research Publishing, P.O. Box 50, 200 Bay Street, Royal Bank Plaza, 29th Floor, South Tower, Toronto, Ontario M5J 2W7. We reserve the right to amend or supplement this policy at any time. July 26, 2017 Mark S.F. Mahaney, (415) 633-8608; mark.mahaney@rbccm.com 12
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Registered trademark of Royal Bank of Canada. RBC Capital Markets is a trademark of Royal Bank of Canada. Used under license. Copyright RBC Capital Markets, LLC 2017 - Member SIPC Copyright RBC Dominion Securities Inc. 2017 - Member Canadian Investor Protection Fund Copyright RBC Europe Limited 2017 Copyright Royal Bank of Canada 2017 All rights reserved July 26, 2017 Mark S.F. Mahaney, (415) 633-8608; mark.mahaney@rbccm.com 14